Evolving U.S. Inflation Dynamics: Explanations and Investment Implications
Joseph H. Davis
The Vanguard Group; National Bureau of Economic Research (NBER)
Inflation is a fundamental macroeconomic risk factor for a broad range of asset classes. Since the 1980s, global inflation has generally trended lower and inflation shocks have become less persistent despite, at times, considerable commodity-price volatility. Will this lower inflation trend persist in the face of potential secular inflationary forces? In this paper, we document the evolving dynamics of the U.S. inflation process. We attribute the profound changes in U.S. inflation persistence to more effective and credible monetary policy, rather than from "globalization" or other structural changes in the economy. Our empirical analysis implies that a low and more stable inflation environment is highly likely to persist going forward, conditional on appropriate monetary policy. We then discuss the potential implications for future short-term interest rates, long-duration bonds, and inflation-hedging instruments.
Number of Pages in PDF File: 19
Keywords: Inflation dynamics, inflation persistence, monetary policy, globalization, interest rates
JEL Classification: E31, E5
Date posted: October 11, 2007 ; Last revised: November 5, 2007